Money Laundering & its Prevention

The recent cases of money laundering unearthed paint a sorry picture of India’s vulnerability in the financial sector. But more than that, Money laundering is a serious internal security threat. In this article, we will try to decode the problem of Money laundering.

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What is Money Laundering?

Money laundering is a process of transforming the proceeds of crime into apparently legitimate money and other assets. It is manipulating the trail of criminal proceeds to disguise its illegal origin.

INTERPOL defines money laundering as, “any act or attempted act to conceal or disguise the identity of illegally obtained proceeds so that they appear to have originated from legitimate sources”.

What is the global status?

The United Nations Office on Drugs and Crime (UNODC) report estimates that in 2009, criminal proceeds amounted to 3.6% of global GDP out of which 2.7% was laundered.

According to the Central Vigilance Commission, the estimated black money in India is around 40% of GDP.

Due to the nature of the transactions, precise statistics are impossible to produce and no definitive estimate of the amount of money that is globally laundered every year can be known.

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How the process of Money laundering works?

The process of money laundering is what makes it very difficult to trace. The process takes form in the following steps

Placement Stage

  • At the placement stage, the money launderer introduces the dirty money into a legitimate financial institution such as banks mostly in the form of cash bank deposits.
  • This is the riskiest stage because large cash amounts are conspicuous. Banks are required to report high-value transactions.
  • So, a large amount of cash is broken up into less conspicuous smaller sums that are then deposited directly into a bank account, or by purchasing a series of instruments such as cheques, money orders, etc which are then collected and deposited into accounts at another location.

 Layering Stage

  • It is the stage at which complex financial transactions are carried out in order to camouflage the illegal source.
  • A series of conversions or movements of the money is done in order to distance them from their source so as to change its form and make it difficult to follow.
  • This may involve several banking transactions, wire transfers in different names across different countries in order to change the money’s currency, and purchasing high-value items to change the form of the money. This is a complex stage where an investigating agency has to work hard to expose the layers.

 Integration stage

  • The ‘laundered’ money is now re-introduced into the legitimate space.
  • At this stage, the launderer might invest the funds into real estate, luxury assets, or business ventures.
  • The launderer now can use the money without getting caught. If there is no documentation during the previous stages, it’s very difficult to catch a launderer during the integration stage

What is the connection between Money Laundering and Crime?

Money Laundering is not an independent crime. it depends upon other crimes known as predicate offence, the proceeds of which is the subject matter of the crime in money laundering.

The predicate crimes can be

  1. Illegal arms sales
  2. Smuggling
  3. drug trafficking
  4. prostitution rings,
  5. Embezzlement
  6. insider trading
  7. computer fraud schemes.

As can be seen from the nature of predicate offense, the offence of money laundering is closely intertwined with Internal security threat.

What are the impacts of Money Laundering?

  1. The reputation of financial institutions and the market is damaged due to the prevalence of laundering.
  2. Democratic institutions lose credibility and confidence of the people.
  3. Destabilises economy of the country which causes a huge financial crisis.
  4. It gives impetus to criminal activities and a vicious cycle is started
  5. Policy distortion occurs due to measurement error and misallocation of resources
  6. Discourages foreign investment in the country.
  7. It provides opportunity to criminals to hijack the process of privatisation through laundered money.

How Money laundering is an Internal security threat to India?

Money laundering facilitates financial resource generation to most of the organized crime. It is the means by which the anti-social and anti-national activities run themselves.

  1. It threatens the financial security of the nation. As most of the money is of quoted Black Money, it creates a parallel economy that threatens the economic security of India.
  2. It distorts the open market mechanism and allows a certain section to manipulate it for selfish benefits. In that process it erodes the credibility and confidence in the market.
  3. Insurgent groups in North-East Generate resources through money laundering and Hawala activities. Drug trafficking is one of the crimes they engage in.
  4. The money laundering funds separatist activities in Kashmir and the dormant Khalistan movement.
  5. India is in proximity of the Golden triangle and golden crescent of drug trafficking. The state of Punjab is fighting against drug addiction problems of the youth.
  6. The young generation which is under drug addiction can be easily drawn into the crime.
  7. There is a linkage of money laundering and political funding during the elections. The black money which enters into electoral politics is a product of money laundering. This threatens Democracy and institutions.
  8. The Money laundered may be used to Fund shady NGOs to work against the interest of the nation by thwarting critical developmental projects.

What are the Legal-Institutional arrangements tackle Money Laundering in India?

In India, the major statutes that incorporated measures to address the problem of money laundering were:

  1. The Income Tax Act, 1961
  2. The Conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974 (COFEPOSA)
  3. The Smugglers and Foreign Exchange Manipulators Act, 1976 (SAFEMA)
  4. The Narcotic Drugs and Psychotropic Substances Act, 1985 (NDPSA)
  5. The Benami Transactions (Prohibition) Act, 1988
  6. The Prevention of Illicit Traffic in Narcotic Drugs and Psychotropic Substances Act, 1988
  7. The Foreign Exchange Management Act, 2000, (FEMA)

But the most effective and directed effort started with the passing of the prevention of Money laundering Act (PMLA) in 2002

Salient features of the PMLA, 2002

  • It forms the core legal framework put in place to combat Money laundering.
  • The provisions of the act are applicable to all financial institutions, banks along with RBI, Financial intermediaries, Insurance companies, mutual funds.
  • It provides for the stringent penalties and jail terms for the convicted
  • Government can provisionally attach and confiscate property of any individual involved in such activities (2012 amendment).
  • The 2012 amendment has also removed the upper limits to the fines that can be levied.
  • The further amendments widen the definition of “Proceeds of Crime” by now including properties and assets created through any criminal activity even if it is not under the PMLA which now will be considered relatable offence.
  • It also allows the government to enter into agreement with other countries for enforcement of the PMLA, exchange of information.
  • It provides for setting up of special courts in states and UTs by the central government to try the cases of money laundering.
  • The Government has constituted the Financial Intelligence Unit, India. The organization receives Cash Transaction Reports and Suspicious Transactions Reports from the banking companies etc. according to Section 12 of the PMLA.
  • The Director, Enforcement Directorate has the powers of investigation and prosecution for offences under the Act.
  • In addition, the Adjudicating Authority as given in section 6 of the Act and the Appellate Tribunal under section 25 of the Act have also been constituted.

What are the International initiatives to tackle Money Laundering?

  • The Vienna Convention
  1. The first major initiative in the prevention of money laundering held in December 1988
  2. It laid the groundwork to combat money laundering by obliging the member states to criminalize the laundering of money from drug trafficking.
  3. It promotes international cooperation in investigations and makes extradition applicable to money laundering.
  4. It establishes that the domestic bank secrecy provisions should not interfere with international criminal investigations.
  • Basel Committee Statement of Principles
  1. The Basle Committee on Banking Regulations and Supervisory Practices encourage the banking sector to ensure that banks are not used to launder funds acquired through criminal activities.
  2. The Statement of Principles extends to all aspects of laundering through the banking system, i.e. the deposit, transfer and/or concealment of money derived from illicit activities which include terrorism, robbery or drug trafficking
  • United Nations Global Programme against Money laundering
  1. GPML (established in 1997) tries to increase effectiveness of international action again money laundering through comprehensive cooperation with the national Governments
  2. It works in three areas namely Technical cooperation, research and analysis and commitment to support the establishment of financial investigation services
  • Financial Action Task Force

It is an inter-governmental body with the objective to set standards and promote effective implementation of legal, regulatory and operational measures in order to combat money laundering and terrorist financing and related threats to the integrity of the international financial system. India is a signatory to the body.

What are the challenges associated with fighting Money laundering?

  • Enforcement agencies lack sufficient capacity, expertise, training and resources to keep up to the sophistication organized crime is getting into. The rapid growth of technology is another issue.
  • Financial sector Implementation agencies are indifferent to the KYC norm as they don’t take it seriously.
  • Hawala transactions are beyond traditional banking sector so KYC cannot prevent them.
  • The tax haven countries facilitate money laundering through providing base to shady shell companies.
  • Corruption in customs and other avenues freely available for smuggling makes it harder to track and bar.
  • The predicate offences are investigated under different laws so it hampers the investigation of the money laundering cases.
  • The collusion of Banking administrators as seen in PNB scam makes all attempts futile to tackle money laundering.
  • This mostly happens because of lack of banking officials of the seriousness of the money laundering issue. They unknowingly abate criminal launderings and cause security threats.
  • There is a lack of cooperation and conversion between different law enforcement agencies to coordinate predicate crime investigation.
  • The provisions of financial confidentiality in other countries is also an issue which makes the de-layering of money trail impossible.

Way Forward

  • There is a need to enlist common predicate crimes to coordinate in the prevention of money laundering.
  • Convergence of different enforcement agencies and other stakeholders.
  • The vigilance department in every financial institution must be upgraded to tackle infiltration of laundered money in the system and attempts to launder money through these institutions must be thwarted in advance.
  • Dormant accounts in banks must be closed because they can be used to launder money. Closing down of over one lakh shell companies is a welcome action in this effort.
  • The capacity building of enforcement agencies such as Financial intelligence Unit and ED in technology and finance is a must
  • A percentage of recovered of money from successful investigation may be used to use in further investigation.
  • National systems must be flexible enough to outsmart newer schemes of Hawala schemers so that they can de-layer the complex web of money trail.
  • Following due diligence process as expected in the PMLA.
  • India must aggressively coordinate with FATF and other global efforts to fight money laundering.
  • The tax havens must be dealt with heavy hand by Regional and global institutions like FATF. Heavier sanction must be considered against them.
  • As FATF recommends, risk identification, policy making and domestic coordination is necessary.
  • UNSC resolutions tackling terrorist financing must be implemented by respective countries and their national agencies. Rouge nations must be punished with sever measures.
  • The FATF must not indulge and fall prey to global geopolitics while dealing with terrorist financing through money laundering as it affects all the countries though in different intensity.

Practice Question for Mains

What is money laundering? Critically examine how recent amendments to the Prevention of Money Laundering Act will help in fighting money laundering.

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